BULL MARKET'S ONE BIG DRAWBACK

The roaring stock market has been good news for nearly everyone. But family businesses, especially those with buy-sell agreements, may no longer view the bull market as a good thing.

When the economy was less robust, family members looking to sell were comforted by the fact that a prospective buyer could go to a bank and borrow against the value of the share being bought. Because the value of that share wasn't inflated, a loan was more feasible, says Jerry Jenkins, a Chicago attorney with Goldberg Kohn Bell Black Rosenbloom & Moritz.

But as corporate valuations have risen, it's become harder to borrow the funds to buy into the firm, Mr. Jenkins says. And if circumstances trigger a buy-sell agreement -- a legally binding document that calls for a partner to sell his share of the firm if a certain event happens -- the seller may have to look outside the family for a buyer.

Yet there are options for sellers in such situations. For example, the prospective seller can go to other stock owners and suggest they all cash out to take advantage of the high values. Or the seller can agree to have the shares valued lower or paid out over a longer period of time. In addition, the departing partner might be persuaded to sell just a portion of his shares, with the remainder purchased by the other partners for a set value at a future date.

For partners who haven't signed a buy-sell, experts say it's never too late, though it's easier when the business is young or when another generation or partner is given shares -- instead of during a crisis or a highly emotional time. Fortunately, the cost is relatively low, typically a few thousand dollars, Mr. Jenkins says.

While he advocates that all small businesses have a buy-sell agreement, he prefers that partners try to negotiate rather than exercise the agreement. "The reason most resort to it is because they think they can cut a better deal," he says.

Following are key points to include in such a document:

* How the valuation will be determined. Terrence F. Netzky, an attorney with Chicago law firm Gould & Ratner, says a method should be determined at the time a buy-sell is written. Attorney Lloyd Shefsky, of counsel at Chicago firm Shefsky & Froelich, recommends a value based on earnings or cash flow that uses a previously determined multiplier.

Partners also need to determine other factors that may influence price, such as goodwill and real estate, Mr. Netzky says.

The three partners at Sawbridge Studios Ltd., a Chicago retailer of hand-crafted home furnishings, decided to value their business according to a three-year average.

"We're a fairly young business, having opened our first store in 1993, and we're still growing gradually," says partner Paul Zurowski. "Only once the business matures and has been around longer will its real value be affected more by the economy and less by growing pains. At that point, we'll probably peg value to a five-year average."

* How often the valuation will be reappraised. While having a buy-sell agreement in place helps avoid problems (or at least lessens potential acrimony), partners must remember to examine it periodically: when economic situations change within the company or in general, when a new family member joins the executive or ownership ranks, when outside management is rewarded with significant company stock options.

Under ideal conditions, partners fix a time frame for how often shares are reappraised.

Mr. Jenkins doesn't like the idea of reappraisals, in part because partners forget or get sloppy about doing them. Worse, owners may decide which role they'll assume -- buyer or seller -- and try to shade the valuation of the company to favor their position.

If they don't want to reappraise, owners can agree to an automatic increase or decrease in value tied to a statistic such as the consumer price index or Dow Jones Industrials Average, adds Mr. Jenkins. A problem with this tactic, however, is that a person may pay more or less for his company according to a valuation that has little to do with the company's actual performance.

* Who serves as appraiser. Some partners hire an outside business appraiser; who it will be and how that person is selected must be spelled out in advance.

* What percentage of ownership each partner receives. Sawbridge Studios' three partners, who are unrelated, own different percentages. Founding partner Mr. Zurowski incurred the biggest risk and holds the biggest stake. Frasier Clark, who helped develop the concept, gets the second-largest share, and silent partner Bill Hiscott holds the smallest.

* Whether other specific arrangements are included. Some common ones include "tag along" or "drag along" rights, rights of first refusal and three-musketeer provisions.

In a tag along, a minority shareholder gets to sell out at the same price per share when the majority owner sells. In a drag along, the reverse occurs: A majority shareholder has the power to require a minority shareholder to sell, as long as he earns the same amount per share.

With a right of first refusal, certain people specified in the buy-sell, and the company itself, get first dibs on whether to buy shares from someone looking to cash out. If they turn down the offer, the potential seller can offer them elsewhere, unless certain limits are in place.

With a three-musketeer clause, partners take the stance of one for all and all for one. If any partner gets an offer, the other partners' shares must be bought at that price, says Mr. Jenkins.

* What situations trigger a buy-sell. Among the possible triggers: an arbitrary earnings number, a change in tax or estate laws, a family member's divorce or any of what Mr. Netzky terms the three D's -- death, disability and disagreement.

* How the company will be run between the time a partner decides to sell and when he eventually departs. This provision may spell out a non-compete clause that stipulates who can't join a competing firm, what companies are deemed competitors and what's considered confidential data.

* The effect of a partner's selling out. One partner's departure may affect not only his position but also other relatives working in the business. Mr. Shefsky terms these persons the "hidden relatives," and says the potential ramifications of how they're dealt with must be addressed from the start.